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The Best Value Stocks

They're not obvious and they're not always cheap.

You think that's crazy? Tell Warren Buffett. He's the one who said it, not me.

But, of course, I think he's right. I'm writing today because the largely semantic differences between value and growth often get lost, even here at the Fool.

Head to headThat's because there is a temptation to equate growth investing with speculation, as fellow Fool Chuck Saletta did here.

But that's just wrong. Real growth investors don't bet on companies whose "sky-high" expectations make it nearly impossible to produce meaningful returns. More often, gurus like Peter Doyle and Murray Stahl of Kinetics Paradigm invest in firms whose superior growth characteristics have yet to be recognized or rewarded by the stock market.

Value investors, on the other hand, look for stocks that trade for less than their intrinsic value, or stocks that the market has unfairly undervalued. Often, these firms are experiencing problems that investors believe to be temporary.

Both strategies, although seemingly different on the surface, operate on the premise that the market has mispriced a stock.

The obvious won't help youHistory proves that you'll need more than math to discern what, exactly, is mispriced. Take the market's 10 best stocks. American Eagle Outfitters was trading for 28 times trailing earnings 10 years ago. A value investor simply looking for stocks with price-to-earnings ratios below the market average would have missed the 32-bagger to come.

Same with Chico's (NYSE:CHS), a 69-bagger, which was trading for 21 times earnings a decade ago. Frontier Oil, a 33-bagger, hadn't produced a penny of profit for three straight years at the dawn of 1997.

The very best value stocksStock market myth says that only value investors zig as others zag. Hogwash. Doyle and Stahl have been buying shares of NYSE Euronext (NYSE:NYX), Leucadia National (NYSE:LUK), and Nasdaq Stock Market (NASDAQ:NDAQ), none of which looks cheap by the numbers. Yet Kinetics Paradigm, by investing where others won't, is a solid market-beater.

David Gardner can claim similar success. When last summer obliterated the returns of his Motley Fool Rule Breakers service, David remained committed to owning businesses whose capacity to rule high-growth industries leads to huge gains in cash flow.

Today, more than 10 stocks in the Rule Breakers portfolio have at least doubled, including digital jeweler Blue Nile (NASDAQ:NILE). No surprises there. It was misunderstood. It was cheap relative to its growth potential. In short: It was a value stock.

Rules breaking, fortunes in the makingDon't make the mistake of confusing growth investing with speculation. You'll miss out on just about all of the market's best value stocks -- the misunderstood multibaggers in the making -- if you do.

Click here now if you'd like to join us at Rule Breakers in our quest to find the market next 10 best stocks. Your pass is free for 30 days and there's no obligation to subscribe.

This article was originally published on Jan. 31, 2007. It has been updated.

Fool contributor Tim Beyers is a sucker for growth stocks and a regular contributor to Rule Breakers. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. Find Tim's portfolio here and his latest blog commentary here. American Eagle is a Stock Advisor pick. Both NYSE Euronext and Blue Nile are Rule Breakers picks. Blue Nile is also a Hidden Gems pick. The Motley Fool's disclosure policy is a rebel on Wall Street.

Author

Tim Beyers first began writing for the Fool in 2003. Today, he's an analyst for Motley Fool Rule Breakers and Motley Fool Supernova. At Fool.com, he covers disruptive ideas in technology and entertainment. Find him online at timbeyers.me or send email to tbeyers@foolcontractors.com. For more insights, follow Tim on Twitter.